US Fiscal Cliff Explained

by

One of the most talked about issues in US politics is the US fiscal cliff.

The fiscal cliff refers to the situation at the end of 2012, where a series of tax increases and spending cuts (worth $600bn)  are due to come into force automatically. This amounts to  This will reduce the budget deficit, but cause lower growth. The alternative is to reject these planned budget cuts and allow the deficit to continue to grow. This will allow stronger economic growth, but leave the debt issue unchallenged.

A complicating factor for US politics is the debt ceiling. This is the legal amount by how much the government can borrow. The debt ceiling can be raised, but it has to go through the Senate to be voted on. This gives scope for political wrangling and efforts to push for some favoured spending cuts in return for allowing debt ceiling to be raised.

The debt ceiling was raised on January 30, 2012, to a new high of $16.394 trillion.

Read more

American Election Economics

by

I only take a passing interest in American politics. I’m just grateful not to live in Ohio, where voters have been subject to hours and hours of political ad campaigns. According to a newsnight presenter, if the 150,000  ads were all lined up, they would last for four consecutive days. (although I’m sure that would constitute cruel and unusual punishment. I think I’d talk after the first six hours). I’ve never seen an American political ad, but I doubt they explain the nuances of balance sheet recessions, liquidity traps and the optimal way to reduce debt to GDP ratios without con straining economic recovery.

But, despite economics being somewhat in the background, the re-election of Obama could be seen as a political confirmation that:

The recession was the result of the financial excesses in the lead up to 2008 – and not really the present administration.

us

Overcoming this unique balance sheet recession was always going to be difficult and long process. The US has performed moderately – but much  better than many of its fellow countries. To some extent Obama deserves credit for allowing a recovery – even if it could have been stronger.

In a country which loves the laissez faire ideal like no others, it’s interesting to still see solid support for the idea that government intervention can actually make markets work more efficiently. Obama supported the rescue of the automobile industry with government money. Romney opposed the use of federal funds. The bailout was a success, so it’s only fair Obama did well in the ‘rust belt’ north. Even the hurricane Sandy is a reminder that for real crisis, government rescue funds can play an invaluable role. Recent years have been a reminder that the highest ideal of government is not just to reduce taxes on the rich.

Read more

Does Disaster Relief Provide Economic Stimulus?

by

Readers Question: “Is it a fallacy to assume that Super-storm Sandy will promote growth and, if so, why?”

In the aftermath of a natural disaster, such as hurricane ‘Sandy’ which recently hit New York and New Jersey. there is usually a fairly minimal impact on GDP.

The devastation by the storm has cost something in the region of $30 billion to $50 billion in economic losses. This approximates to around 0.25% of nominal US GDP. These economic losses include:

  • Damage to property, assets, infrastructure and factories.
  • Lost output because people can’t work. If affected areas lose 25% of output for two days, this would add up to around $6billion of GDP.
  • Lost tax from lower revenues.

The worst losses will not be visible in GDP statistics because much of the damage has come to wealth as opposed to output. In this case, GDP statistics are not a true reflection of living standards because of their focus on output and income – as opposed to wealth.

Read more

Can we save our way out of the Pension Crisis?

by

Readers Question. We hear much about the “pensions time bomb”, as people tend to live longer and there is a bulge as “baby boomers” reach retirement age. We also hear much about the need to save for retirement. Saving *money* may mean people have more money in retirement but surely the real problem is to ensure there is more output; money is worth only what it can buy. Is there a risk that money saving will simply reduce current output and so reduce the income and incentives needed to ensure we have the investment that will enable us to increase output over time?

It is easy to see how it makes sense for an individual to save for retirement but at the national level, it may be counter-productive.

Basically, is there a concern that higher savings for pensions will lead to lower economic output?

 

Forecast for Dependency Rates

Source: Dept for work and Pensions

Firstly, western economies do face a pension time bomb. Dependency rates are forecast to rise (though the UK is unlikely to be as badly affected as other countries, such as Spain, Italy and Japan.) An ageing population means state pensions will take up a bigger % of GDP. Higher savings would help with the private sector pension deficit and provide more funds for pensions. But, would higher savings lead to lower growth?

Read more

Why Government Debt Forecasts were wrong

by

One feature of the recent crisis has been the degree to which governments underestimated the forecast rise in government borrowing. The IMF produced a report which looked at forecast debt from 2007, and what debt actually was three years later. In ten selected countries, the increase in the gross debt ratio 31.8

  • 2007 forecast for debt in 2010 – 58.8% of GDP.
  • Actual government debt in 2010 – 90.6% of GDP

To some extent, this reflects the wider failure to forecast the recession. As well as underestimating debt levels, governments proved widely optimistic on GDP and unemployment. However, the recession wasn’t the only reason for governments to underestimate debt levels. There were also failures to account for liabilities, such as hidden obligations to public corporations and Public private finance initiatives. This shows that many countries need to improve their fiscal transparency.

  • Fiscal transparency can be defined as the clarity, reliability, frequency, timeliness, and relevance of public fiscal reporting and the openness to the public of the government’s fiscal policy-making process.

Why Forecasts were Wrong

There was quite a degree of variability in why debt forecasts were wrong. For example, in the UK there was only a minor underestimation of its fiscal position (3.7% of GDP). Most of the UK’s higher than expected debt were a consequence of the unexpected recession and financial sector intervention.

Read more

Is Economics Irrelevant in the Absence of Scarcity?

by

Readers Question Is the study of economics irrelevant in the absence of the concept of scarcity? It would make a good interview question. The difficult thing is trying to imagine what a society would be like if it had no scarcity. One thinks of the imaginary desert island, with abundant resources and a lone Robinson …

Read more

Did Generous Welfare Payments Cause the Recession and Unemployment?

by

Casey B. Mulligan, from the University of Chicago suggests a theory for a major cause of the great recession and the rise in US unemployment post 2008. – Higher welfare payments.

..Redistribution, or subsidies and regulations intended to help the poor, unemployed, and financially distressed, have changed in many ways since the onset of the recent financial crisis. The unemployed, for instance, can collect benefits longer and can receive bonuses, health subsidies, and tax deductions, and millions more people have became eligible for food stamps.

Economist Casey B. Mulligan argues that while many of these changes were intended to help people endure economic events and boost the economy, they had the unintended consequence of deepening-if not causing-the recession.

The Redistribution Recession – Oxford University Press

us unemployment
US Unemployment – was it caused by generous benefits?

There is also an article here at the NY Times (paywall): A Keynesian Blind Spot.

The decline of home construction is not the primary reason that our labor market remains depressed: Keynesian policies are

…

Read more

Why Did Europe Expect Fiscal Consolidation to Work?

by

Readers Question. Can you explain why the Government and Economic Commentators  are talking about a multiplier (in relation to budget cuts) of between 0.5 and 1, whereas I always thought that the GDP multiplier was bigger than this.

Just to summarise a multiplier of 0.5 would mean fiscal consolidation (spending cuts) of £1bn, would lead to a drop in GDP of only £0.5bn. In other words, they hoped fiscal consolidation would be successful and only have a limited impact on reducing economic growth rates.

However, evidence from the IMF and other studies have shown the fiscal multiplier has proved much higher. In fact a multiplier of up to 2. (for every spending cut of £1bn, we have seen GDP fall £2bn. See: Fiscal multiplier and European austerity).

Essentially, this shows the limitations of using economic models which are applied during very different economic circumstances. If you look at previous attempts at fiscal consolidation undertaken during strong economic growth (e.g. Canada in 1990s), a multiplier of 0.5 would be quite reasonable.

However, there was an unwillingness to admit that the economic situation in the aftermath of a financial crisis and liquidity trap was very different.

 

Why might the Government and European Commentators expect  a multiplier of 0.5?

To some extent, I answered this yesterday on the post – why austerity will increase the budget deficit. But, just to recap, the may have hoped for a multiplier of 0.5 because:

1. Expansionary monetary policy. With spending cuts, usually a Central Bank can cut interest rates and loosen monetary policy so that there is a boost to demand to offset the impact of tax increases and spending cuts.

  • But, the EU and UK government should have realised that interest rates were already at record lows in 2010. Quantitative easing has done little to boost spending in the UK. In Europe, the ECB has never showed any real sign of loosening monetary policy in response to fiscal consolidation. In fact in 2011, the ECB increased interest rates over misplaced fears on inflation.

Read more

Continue Shopping →
Item added to cart.
0 items - £0.00
Checkout